Lotteries for consumers versus lotteries for firms

Edward C. Prescott emphasizes similarities between lotteries that smooth nonconvexities for firms and for consumers–workers. We emphasize their differences. We also argue that models with employment lotteries that are used to generate unemployed individuals in a frictionless framework can have implications very different from those of models embodying frictional unemployment. As an illustration, models with employment lotteries predict effects from job destruction taxes that are the opposite of those in search models. James Tobin said that good macroeconomic analysis ignores distribution effects. But in general equilibrium theory, distribution effects usually can't be ignored. Edward Prescott's paper is an elegant summary of a very successful research agenda that manages to apply general equilibrium theory to macroeconomics by carefully setting up redistribution arrangements to smooth the nonconvexities that are confronted by both firms and households, which thereby deliver both a stand-in household and a stand-in firm. Prescott's work continues the Tobin tradition not by ignoring distribution effects but by designing them to facilitate aggregate analysis. There is much to admire and to copy in Prescott's work in general and in this paper in particular. This is a perfect paper to assign to graduate students. A beautiful aspect of the paper is that because it adheres to the rules for describing competitive equilibria, everything is in the open. We take advantage of this openness to emphasize and challenge an important aspect of Prescott's analysis.